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In our PhD Economics program at Stanford, we learnt nothing about the history of major economic events of the twentieth century. Instead, we were taught the rather arcane and difficult skill of building models. In order to analyse what would happen in an economy, we learnt that you have to construct an artificial economy, populated by rational robots called homo economicus, who behave according to strict mathematical laws. At no point in our studies were we asked to match what happens in our models with any events in the real world; it was assumed that the two always matched. This process of economic modelling permits us to provide exact mathematical answers to a vast range of questions one might ask about the economy. This is undoubtedly a powerful technique, which has earned economics the name “Queen of the Social Sciences”. Our poor cousins in political science, psychology, sociology, geography, and so on, have to study the more complex real world, and cannot offer anything comparable. Nonetheless, the power of mathematical modelling derives from the extremely unrealistic assumption that real world events and human behaviour can be predicted by mathematical formulae. Thus, the precise predictions of economists are often dramatically contradicted by real world outcomes. As Nobel Laureate Paul Krugman remarked after the global financial crisis took economists by surprise: “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”

My own education in economics began many years after graduate school, when I chanced across a copy of Economics and World History: Myths and Paradoxesby Paul Bairoch. Bairoch’s book challenged one of the holy cows of economic theory, that free trade is always a superior policy for all parties. Believing in free trade is a hallmark of economists — a recent survey showed that 90 per cent of economists believe in it, while only 20 per cent of the general public believe that free trade is always optimal. So it came as a shock to me when Bairoch discussed many historical episodes to show that free trade had caused harm to the less developed nations, by preventing development of industries, and also by creating unemployment. Many nations with strong industries had built them up under the umbrella of protection, contrary to free trade principles. This historical evidence was strongly in conflict with the mathematical demonstrations of superiority of free trade that I had learnt in graduate school. In bewilderment, I asked several of my mentors, very senior and respected economists, about this. I was even more surprised by the responses I received. None of them were familiar with the historical evidence, and furthermore, they did not find it relevant. They argued that if protection provided good results, then free trade would have provided even better results. The mathematical proofs were impervious to empirical evidence.

Economists do not study history because it is a record of particular events, while they search for universal scientific laws, which would be equally valid among the Aztecs and the Zulu, in the nineteenth century and in the twenty-first. I realised that the laws of economics hold only in an imaginary world populated by robots, and that to learn real economics, it was necessary to study history, which I had bypassed in graduate school. It was only after many years of detailed historical studies of real world economic events that I came to realise that nearly everything I had been taught in graduate school was wrong.

Recent historical events have shaken the faith of many true believers in free market economics. A landmark 2013 study by Autor, Dorn and Hanson, found that competition from China has destroyed jobs and lowered wages in many US industries, especially manufacturing. Contrary to economic theory, which states that the displaced labourers will find better jobs in different sectors, workers displaced by Chinese competition often went on the government dole. A large group of heterodox economists, students and laymen are becoming increasingly aware of the lack of realism, ideological bias, and lack of concern with poverty and inequality, which are hallmarks of modern economic theory. However, dissent is weak and dis-united, while orthodoxy is firmly entrenched in the halls of power. The task of creating a new economics remains as essential as it is undone.

Keynes’ attempt to re-shape the world order in the 1940s highlighted the need of an international currency system that might only work by means of a “wide measure of agreement”, that is, by means of the creation of a new international convention. In Keynes’ time, this convention would rely on multiple needs: an international currency, a stable exchange rate system, redistribution of international reserves, stabilizing mechanisms, sources of liquidity, besides a central institution to aid and support other international institutions related to the planning and regulation of the world economic life. In our times, new convention-conducing institutions could foster financial regulation.

As global finance has subordinated the outcomes of social reproduction, the main question is, as Hyman Minsky warned, Who will benefit? The recent global crisis has indicated that the structure and dynamics of current global finance, as a historical set of institutions, products, procedures, behaviors and policies have potentially materialized the risk of collapse of the financial system with deep negative consequences for the real economy and society. In order to support sustainable development, it’s time to stimulate students to rethink global finance, as well as its policy agenda about global and corporate governance, prudential regulation and supervision of systemic risk.

Considering the current global scenario, we need real world economists to re-conceptualize financial problems. The understanding of these financial challenges requires new perspectives regarding knowledge, abilities and attitudes in order to rethink alternatives. As the organization of economic and social institutions helps to define policy goals and outcomes, students should reflect on how to promote a new relationship between the financial and industrial spheres, which is required to promote growth and income distribution. Here, the economic agenda involves aggregate demand (fiscal and monetary) and income policies besides the articulation of financial flows in both credit and capital markets. Under this perspective, the role of monetary policy could be highlighted through the participation of central banks in redirecting flows of credit. It is necessary to articulate the flows of credit within the framework of industrial and labor policies that would search for alternatives to the market power of global corporations. It is also time to think about capital controls that might reduce the effects of sharp reversal short-term capital flows.

In fact, any transformation in economic curriculum needs to look forward to search for more coherence in the approach to the relationship between finance and sustainable development both in micro and macro courses. This approach must emphasize a historic understanding of business dynamics, since economic decisions are based on conventions that in turn are based on trust. Indeed, trust is a conventional concept related to the level of confidence built in a society around the legal, regulatory, political and economic setting. In other words, trust has a social and historical nature. It’s time for explicitly introducing this discussion in the economics curriculum.

During the last thirty years, most governments around the world have supported the long-run process of financial expansion that turned out to be characterized as the “financialization” of the capitalist economy. In this historical scenario, monopoly-finance capital became increasingly dependent on bubbles that, both in credit and capital markets, proved to be global sources of endogenous financial fragility. Financial and currency crises have also revealed that monetary and supervisory authorities do not cope with the complexity of the global, profit-seeking, innovative and speculative portfolios of investors and banks.

Central banks, in a context of financial liberalization, do not face financial disturbances easily. Indeed, credit squeeze, volatility in the valuation of assets, the menace of recession, the shift of investors toward liquid and safe assets, among other factors, put pressure on central banks and treasuries.

The idea of autonomous monetary management collapsed under the 2008 global financial crisis. As a matter of fact, the crisis showed that the central banks´ actions are not independent from private and public pressures. The social conflicts that emerged within the markets shifted to the political sphere and proved to challenge money as a public good – since livelihoods have been subordinated to the bailouts of the financial systems. Besides, the increasing growth of sovereign-debts has imposed the adoption of austerity programs which burden that mainly rely on workers and taxpayers.

Indeed, since the global financial crisis, monetary policy has been brought to the forefront. Considering this background, we welcome the recent Edward Elgar publication of The Encyclopedia of Central Banking, edited by Louis-Philippe Rochon (Associate Professor and Director, International Economic Policy Institute, Laurentian University, Sudbury, Canada and Co-editor, Review of Keynesian Economics) and Sergio Rossi (Full Professor of Economics, University of Fribourg, Switzerland). The entries of the Encyclopedia provide an update and a critical understanding of the complexity of monetary-policy interventions, their conceptual and institutional frameworks, and their own limits and drawbacks. Besides, controversial explanations of financial institutions, policy monetary tools and the crisis are presented from a historical perspective.
Indeed, this Encyclopedia certainly provides the pluralistic view we need to privilege in the contemporary studies of central banking.

There is widespread agreement on the proposition that people act according to their self-interest. Marx went further to suggest that people subscribe to ideologies conforming to their class interests. For example, agricultural laborers would believe in land reforms, while big landlords would believe that small farms are inefficient. Gradually the weight of strong empirical evidence has led me to understanding that this proposition is false. Large segments of the population can be brought to believe in, and act according to, ideologies extremely harmful to their self interest. As Dani Rodrik has written in “How the Rich Rule”, political scientists Gilens & Page found that on issues where there was a conflict between the interest of the elite and that of the public, Congress voted in favor of the elite and against the public interest. In the past, the elites have enforced their interests by the use of power. In a democratic age, the same effect is achieved by the use of propaganda. This is striking because the propaganda must convince the public to act against their own self-interest, in favor of the ruling elites. It would seem that you can fool most of the people most of the time. Here is some empirical evidence for my thesis: Read More

Modern financial institutions, instruments and their underlying philosophies clash with Islamic law in many areas. For some time, both critics and supporters have thought that these Islamic laws were in need of revision to bring them into conformity with the complexities of modern requirements of trade and industry. Critics have been content with ridiculing the “archaic” law. Supporters have made substantial efforts to provide “Islamic” equivalents of modern western financial institutions and instruments. Many have been uneasy with these efforts, which often seem pointlessly convoluted ways of imitating western ideas about finance. There is also the concern that Islamic laws are being stretched beyond the breaking point to accommodate western forms. The global financial crisis of 2008 has led to the radical realization that instead of being obstacles to progress, the Islamic laws provide barriers against financial disaster. Many western commentators have remarked that adherence to Islamic economic principles would have prevented this crisis. Challenges, a French magazine, went so far as to say that the 7th century text of the Quran offered better guidance than the Pope on financial matters.Read More

The Great Depression of 1929, and now the Great Recession following the Global Financial Crisis, poses several puzzles for economists. One is them is the sudden and severe drop in aggregate demand. This leads firms to curtail production, and therefore reduces demand for factors of production, most importantly labor. Why does aggregate demand fall, and why do not the price adjustment mechanisms restore equilibrium? The outstanding contribution of Atif Mian and Amir Sufi in House of Debt (see my Review & Summary) is to explain both why aggregate demand fell and also why the standard price adjustment mechanisms fail to restore equilibrium. The correct explanations have eluded famous economists like Keynes, Friedman, Lucas and many others . Only after understanding the reason for the shortfall in aggregate demand does it become possible to prescribe a remedy.

I have written a summary of the main arguments of Mian and Sufi in “House of Debt”. This book provides the answer to the question “How does macro-economics need to change, in light of the Global Financial Crisis?” This has been asked of many but none have given a satisfactory answer. Mian and Sufi analysis is to the GFC what Keynes was to the Great Depression — in fact Mian and Sufi provide the first satisfactory explanaton for both events. My full length review is available from SSRN at: http://ssrn.com/abstract=2517476.. Below I provide an excerpt from my review which gives the history of the Global Financial Crisis, linking it causally to the East Asian Crisis. Read More